Tips on when to prioritise debt over saving and the difference between good debt and bad debt.
When to prioritise debt over savings
The best place to start is looking at how much interest you’ll be charged on debt versus how much interest you’ll earn through saving.
If the interest you’ll be charged is greater than the interest you’ll earn, it’s likely to be a good idea to put as much money as you can towards repaying debt before building your savings.
It’s also worth thinking about what funds you’d have available in case of an emergency. Ideally you’d have an emergency savings fund that can cover at least three months’ worth of expenses.
But until then, having the balance available through a credit card can at least help put your mind at ease. That way you can focus on repaying debt, knowing that if something costly happens you’ll be able to cover it.
When to prioritise savings over debt
Some debts don’t need to be repaid straight away. For example, with a mortgage or personal loan you’re likely to have an agreement with your bank about how much you repay a month.
Once you’ve covered those repayments, any extra funds can go into your savings.
If you don’t have one, start by building an emergency fund that can cover three months’ worth of expenses.
Once you have an emergency fund, consider what’s important to you. You may want to:
- build savings further
- make overpayments on your personal loan or mortgage (check if there’s a charge to do this)
- consider investing for the long term
- add money to your pension to take advantage of tax allowances
Good debt vs bad debt
As well as knowing when to repay debt and when to save, being a savvy borrower means knowing the difference between types of debt. Often people speak about good debt and bad debt.
Good debt can help you become better off over the longer term.
It could be for:
- buying a home
- buying something that helps you earn an income
Bad debt can cost you a lot of money and not leave you financially better off.
It could be for:
- items that won’t grow in value, like a holiday or car
- paying bills, or covering everyday expenses
It’s important to keep in mind that not all long-term borrowing is good and not all short-term borrowing is bad. For example, if you use your credit card to make ends meet, but repay it in full each month then you won’t be charged any interest.
And if you have a mortgage that’s costing you too much and you’re struggling to meet other costs, it’s not necessarily ‘good debt’.
Each situation and debt is different. What’s important is to recognise your limits and make sure you’ve got a clear repayment plan you’re comfortable with.